Gold - Sell The Rumor, Then Buy The Rate Hike

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Includes: ASA, DGL, DGLD, DGP, DGZ, DUST, DZZ, GDJJ, GDX, GDXJ, GDXS, GDXX, GEUR, GGN, GHE, GHS, GLD, GLDI, GLDW, GLL, GOEX, GTU, GYEN, IAU, JDST, JNUG, MELT, NUGT, OUNZ, PHYS, PSAU, QGLDX, RING, SGDJ, SGDM, SGOL, TGLDX, UBG, UGL, UGLD
by: Andrew Hecht

Summary

2017 looked a lot like 2016 until the rally ran out of gas.

The counterintuitive move.

Certainty or uncertainty - that is the question for the yellow metal.

Three reasons to be bullish on gold.

Three reasons to be careful in the current environment.

Gold is a barometer of many things. Perhaps the most important factor that affects the price of the yellow metal is inflationary pressure. When paper money loses value via the evils of inflation, gold has historically kept its value. Paper money these days is only supported by the full faith and credit of the nations around the world that print the notes and mint coinage. Therefore, when confidence in governments declines, the value of money should decrease commensurately. Gold is also a measure of fear and uncertainty in markets. A flight to quality in asset markets tends to cause the price to move higher, and when stability and calm dominate the market psyche, gold tends to decline in price. Gold is also an instrument for flight capital. Since a 100-ounce bar of gold weighs fewer than seven pounds and is worth$123,000 at $1230 per ounce, it is an easy way to transport wealth at periods when time is of the essence.

Gold traded to highs of over $1920 per ounce in 2011 and fell to around the $1046 level in late 2015. In 2016, gold rallied throughout much of the year, but a bearish key reversal trading pattern in the aftermath of the U.S. election in November took the market back down to a low of just under $1124 per ounce in December after seeing highs of over $1376 in early July. The bulk of the selloff came in November as the yellow metal dropped from almost the $1340 per ounce level. The recovery that followed took gold higher until the end of February.

2017 looked a lot like 2016 until the rally ran out of gas

On February 27, the price of gold traded to a high of $1264.90 per ounce and it seemed like the price action in 2017 was on course to be a carbon copy of last year's bullish start to the year. In early February, the market assigned a 20% chance that the Fed would raise interest rates at their March meeting but as the meeting approached the likelihood of a rate hike became a 100% certainty. Gold responded along with other interest sensitive assets and the price went lower. Source: CQG

As the daily chart highlights, the price of the yellow metal declined from $1264.90 on February 27 to lows of $1194.50 on March 10 the Friday before the Fed meeting. During the week of the FOMC gathering to decide on interest rate policy, gold traded around the $1200 per ounce level just a couple of bucks above the lows. In hindsight, the Fed hiked rates twice over recent years, in December 2015 and 2016 in both months gold made a significant bottom and rallied after the Fed action.

Gold ran out of gas in February and did not gain 11% during the second month of 2017 as it did in 2016. However, the precious metal found a bottom before the March Fed meeting and when the central bank announced a 25 basis point increase in the Fed Funds rate the price took off to the upside.

The counterintuitive move

It turned out that the prospects of a rate hike were a lot worse for the gold market than the actual deed as gold wasted no time rallying to the $1220 per ounce level in the hours following the Fed move. On Friday, March 17 the price was around the $1230 level. Meanwhile, the statement and press conference that followed the hike was not all that hawkish. There was one dissenter who wanted to leave rates unchanged. Not one member of the committee feared the evils of inflation enough to suggest the heretical strategy of a 50 basis point hike. The Fed told markets to expect another two hikes in 2017 which was consistent with the statement that accompanied the last increase at their December meeting. The rest was more of the same from the central bank; the economy continues to grow at a moderate pace, the job market is strong, and they expect that the GDP will grow by 1.8%. The one slight change in the statement was the business fixed investment has "firmed," in past comments the Fed had expressed concern about business investment. During the press conference that followed the rate hike, Chairperson Yellen told reporters that optimism is high in markets and she believes that there is good reason to be optimistic. Her optimism launched the equity markets higher. According to the Chairperson, Fed continues to be predisposed to act in an accommodative fashion, which might have been the charm for gold which moved higher alongside other precious metals.

Meanwhile, it now seems when there are prospects for a rate hike it is bearish for the yellow metal, but the actual hike itself is a launching pad for the price of gold.

Certainty or uncertainty - that is the question for the yellow metal

As a barometer of fear, gold is an asset that has a habit of waving a cautionary flag. The stock market has been on a one-way street higher for months. There are many signs of inflationary pressures creeping into the U.S. and global economies after years of accommodative monetary policies. The past multilateral trading relationships are being questioned and renegotiated by President Trump who prefers to deal on a bilateral basis. Tax policy in the U.S. is about to change. The bottom line is that the political changes that occurred in 2016 delivered in the form of the Brexit referendum and U.S. election were watershed events that will continue to cause change and create uncertainty that will support the price of gold.

Three reasons to be bullish on gold

These days, I believe there are three overwhelming reasons to be bullish on the price of gold.

Faith in status quo governments

If last year told us anything, it was that many citizens around the world have become fed up with politicians and politics as usual. Paper currencies are governmental IOU's only have the backing from the full faith and credit of the country that prints the money. As confidence declines, credit deteriorates, and the value of all money decreases when compared to gold.

Lack of experience in those replacing the status quo

Given the disgust with politicians who promise the world and deliver little, we have seen the election of an outsider to Washington as President of the United States. We have witnessed the people of the United Kingdom reject the comfort of an economic and political alliance with Europe to go it on their own. While the choices have brought about fundamental changes, the new leadership will need to break new ground and mistakes are probable along the way. Political missteps, when it comes to domestic or foreign policy, will create periods of uncertainty that will support the price of gold and other hard assets as investors and traders flock to quality.

The rise of Bitcoin is an example

While you may love the idea of Bitcoin or think it is a scam, the price appreciation commands attention as the cryptocurrency is making an important statement about government institutions around the world. Source: Coin Desk

Bitcoin is an asset that has grown in popularity because of the lack of interference from politicians, central bankers, monetary authorities, supranational institutions, and regulators around the world. The price of the cryptocurrency is the result of the bids and offers in the market at any time. In 2010, Bitcoin was trading at around 6 cents, and as of March 15, the price reached an all-time high of over $1290 over recent weeks. For a time, Bitcoin traded at a price that was greater than gold. Is Bitcoin better than gold? From a purely financial perspective the jury is still out.

Whether you believe in Bitcoin or not, the rise in value has been spectacular, and the reason for its increase is a signal for another asset that transcends the big hand of governments, and that is a global means of exchange. I believe that Bitcoin's ascent is an indication for the future path of gold.

Three reasons to be careful in the current environment

I am positive on gold for the long haul and believe that every portfolio should contain from 5-10% of the yellow metal. However, with all assets, there are risks and the current environment presents some challenges to the ascent of the precious metal.

Higher rates will bite

The path of least resistance for U.S. interest rates is higher. Since December 2015 the Federal Reserve has increased the Fed Funds rate three times with the most recent hike coming last week. Longer-term rates have forced the hand of the Fed in many ways. Source: CQG

As the monthly chart of the U.S. long bond highlights, since July the price has dropped from 177-11 to lows of around 147 recently. It is likely that there will be at least two more rate increases in the U.S. in 2017.

In Europe and Japan, short-term rates cannot go much lower as they current stand at negative 40 basis points. Traditionally, increasing interest rates are bearish for gold. As we have witnessed, when market sentiment starts to expect an increase in borrowing costs gold tends to head lower. Therefore, we could see some significant selloffs in the price of gold in the months ahead.

The dollar has fundamental winds behind its sail

The dollar has been in bullish mode since May 2014 when it took off from the 78.93 level on the dollar index futures contract. Source: CQG

As the monthly chart illustrates the dollar traded at the highest level since 2002 in January 2017 and has since moved back to around the 100 level. However, interest rate differentials between the greenback and other currencies favor the dollar as it offers a higher yield and the opportunity for capital appreciation given the trend. A strong dollar tends to be historically bearish for the price of gold, and that presents a challenge for the yellow metal as the trend of the U.S. currency continues to be definitively higher.

The technicals continue to confuse

When it comes to trends, gold is currently not providing a clear picture when it comes to the path of least resistance for the price. Source: CQG

On the daily chart, momentum has shifted to the upside after the most recent price correction. The slow stochastic has crossed in oversold territory indicating that further gains are probable. The weekly chart shows that gold is currently attempting to cross to the downside in close to overbought territory and that more losses are possible. Source: CQG

Meanwhile, the monthly pictorial displays that gold is still in a downtrend after the bearish key reversal trading pattern in November. The technical picture remains cloudy and the fundamentals, while supportive, have roadblocks that could cause a rocky road for the future of gold and all precious metals.

One last cautionary note, last week when gold recovered the gold mining stocks did not explode higher as they have in the past when gold began to rally which is a reason for a conservative approach at this time.

I like gold these days, and I think the price is heading higher, perhaps much higher over the months and years ahead. However, the yellow metal will not travel in a straight line. The latest lesson from gold seems to be to sell the rumor of Fed action and buy the rate hike.

I have introduced a new weekly service through Seeking Alpha Marketplace. Each Wednesday I will provide subscribers with a detailed report on the major commodity sectors covering over 30 individual commodity markets, most of which trade on U.S. futures markets. The report will give an up, down or neutral call on these markets for the coming week and will outline the technical and fundamental state of each market. At times, I will make recommendations for risk positions in the ETF and ETN markets as well as in commodity equities and related options. You can sign up for The Hecht Commodity Report on the Seeking Alpha Marketplace page.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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